Thursday, May 01, 2008

Supply Response and Self-Unfulfilling Recession Prophecies

In a post last year, I argued that one reason economists have not successfully forecast recessions is that recession forecasts, or near-recession forecasts, prompt policymakers (usually the Fed) to act so as to prevent a recession. Only when the recession is unexpected (i.e. not forecast) will policymakers fail to act.

Spencer, an occasional blogger at Angry Bear and a frequent commenter on many different economics-oriented blogs, suggested (in a comment somewhere; I don’t remember where or when) another mechanism that operates through inventories. When manufacturers expect a recession, they reduce their inventories in anticipation, thus inducing themselves to increase production later, thereby preventing the recession they had expected. So again, a recession only occurs when it is unexpected, when manufacturers are caught with excess inventories because they hadn’t anticipated weaker demand.

Here I’m going to suggest a third mechanism whereby forecast recessions may tend to prevent themselves. The idea comes from this YouTube video, in which a model* discusses, among other things, her concerns about the weakening economy. Her response to those concerns: “I’m trying to book up as much work as I possibly can and get some savings cushions built up.”

This phenomenon may be specific to the modeling industry. Indeed, it may be specific to the particular model in the video. But I see no reason not to expect it to be more general. Intertemporally optimizing businesses, and self-employed individuals, in many service-producing industries (and for that matter, workers in all industries) may have a general incentive to shift their supply curves outward in response to the expectation of a future inward shift in demand curves. Thus the expectation of a recession would result in an immediate increase in economic activity.

I’m not sure what the full implications of this hypothesis are for the business cycle. It’s kind of the opposite of Spencer’s idea, in that here the expectation of a recession causes agents to produce more in the immediate time frame rather than less. I suspect, though, that manufacturers are better at planning at quarterly or longer horizons than are service-producing industries (and certainly individuals), so I suspect that the paring down of inventories happens well in advance of the expected recession, whereas the supply curve shift happens at about the time the recession is supposed to start. (The video example, one may note, took place in mid-April of this year, by which time many people believed that the US was already in a recession.) If the supply response is tardy enough, it could surely have the effect of preventing (or at least delaying) the recession to whose forecast it is responding.

*UPDATE: It occurs to me that I should identify the model, instead of just exploiting her as an example of a concept. Her name is Isobel Wren. She has a nice portfolio on One Model Place, and she also has her own Web site (Adults only. Not work safe.). She calls herself "the thinking man's nympho" and prides herself on being a nerd when she's not in front of the camera.

I take it this is (more than) slightly tongue in cheek. As I'm sure Dean Baker has pointed out, economists almost never forecast recessions until they are already there.

There should be evidence for this theory somewhere shouldn't there. If this was the case, why did inventories increase so much in the first quarter this year? I can think of just as many (and more dramatic) effects that work the other way (consumption/fixed investment effects for instance).

Judging by how tired she looks in this video, I think the demand for her work is out there. But you're probably right that, overall, the demand response would outweigh the supply response. The video kind of made me realize, though, that in some businesses, the amount of activity is determined in large part by how much work people are willing to do and how aggressively they pursue potential opportunities. And the supply effect can also produce an indirect demand effect, demand for complements to what is being supplied (maybe lighting technicians in the case of modeling, thought that example might be outdated).

She kinda looked high to me. (Maybe she's working so hard she has to get high to be able to relax and get some sleep.)Sometimes contracts actually come after you, with no effort on your part. If you're one of those people who can't say no, you can end up with too much on your plate. Contracts are short term - according to the permanent income hypothesis (and the model), one really does want to either build up assets or pay up liabilities.On another note, I am of a curious nature and really had to look up "reason" and I am wondering what you by going back to first principles.

I doubt she's high. In another video she said that she thought of taking some of her prescription cough medicine to help her sleep but decided not to because "that's too much like abuse of a controlled substance for my taste."

But which video looks like she's high? In the video I linked from the main post, I don't think she looks high at all. In the video I linked from the comment, she definitely looks high -- or strung out -- or wasted. But I think it's just because she's very tired and a little sick and had a tough shoot that day. Bear in mind that she does a lot of fetish/BDSM stuff that can involve things like electric shocks and being tied up in a cage, so "a tough shoot" doesn't just mean she had trouble finding a pose that would please the photographer. Throw laryngitis and possibly several on-camera orgasms into the mix, plus the fact that she spent the previous weekend screaming at bands at Coachella music festival, and you can understand why she might not look the picture of sobriety.

I was referring to the second video where you said she looked tired. I have to admit I didn't watch the whole videos - she's cute, but I'm pretty busy (although I had something other than work in mind for this week-end, which didn't pan out in the end). You seem to have a better handle on her situation than I do, so I will defer to your interpretation.

Actually, the thing about the cough medicine was in her text blog, not in a video; I remembered that wrong. The exact quote: "...that's a little bit too much like abuse of a controlled substance for my liking."